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J&J, Time Warner Narrow Peer Group Focus
05/01/06
By: Eddie Lull, Base & Bonus - Board Alert
Johnson & Johnson and Time Warner have cut back significantly on the number of companies they use as a benchmark for setting their executives’ compensation.
Johnson & Johnson whittled the number of companies in its peer group from 45 down to 12. Time Warner, which had used four groups of peers, now uses only three groups.
Debate over peer groups has increased of late as more companies have responded to governance pressure to provide greater disclosure about the companies they use as a benchmark.
The SEC wants companies to include an explanation of the peer group in its proposed compnsation discussion and analysis section. If a company uses a peer group, the comp committee will have to explain it in this new section, explains Mike Melbinger, partner with Winston & Strawn. “The SEC wants the comp committee to talk about how they set their peer group and why they picked the companies they did,” he says.
At the same time, many compensation committees are undertaking wholesale reviews of their compensation plans amid greater scrutiny and regulatory charges affecting compensation. That, too includes what peer groups they use.
Johnson & Johnson directors wanted a more focused approach to peer groups based on both pharmaceutical companies and other large companies, the March proxy states
By narrowing the field, the directors believe that they are left with a group of companies that are more comparable to theirs “in breadth, complexity and scope of responsibilities; [that] have global businesses; and compete with the Company for executive talent.”
Time Warner, meanwhile, explained in last year’s proxy statement that beginning in 2005 it would no longer use a peer group comprising the 50 largest U.S.-based publicly traded companies.
In this year’s April proxy filing, the company explains that the peer groups it uses include one comprising major media and entertainment companies; another comprising a group of technology, media, telecommunications and consumer products companies; and a third comprising companies with more than $10 billion in revenues.
Time Warner made the change, much like Johnson & Johnson, in order to “reflect a more targeted approach to evaluating competitive compensation levels.”
But the closer look bards are taking at their peer groups isn’t confined to narrowing those groups. Several companies have expanded their peer groups.
Continental Airlines expanded its peer group to include more low-cost airlines. International paper reevaluated its year-old methodology of using two different peer groups, one to measure return on investment and another concerning total shareholder return. The company decided to expand the shareholder return peer group from 10 to 18 companies.
And Pepco Holdings, the $8 billion electric power company, expanded its peer group from 20 to 24 companies and also revamped the group to make it more appropriate, according to a recent SEC filing. The previous peer group had seven gas-only utility companies. Its new peer group has just one such company.
Depending on the specific situation, narrowing the scope of the peer group can hurt its effectiveness, says Paul Dorf, managing director of Compensation Resources.
Data Culled from a smaller group can easily be distorted if even one of the companies goes through a destabilizing event such as a merger, bankruptcy or even an unusually good or bad year in its sector. “The bigger the universe, the more reasonable would be the comparison,” Dorf says.
On the other hand, if some companies in a peer group don’t reflect the company in question in enough ways – or specifically enough – then they dilute the applicability of the group.
Experts say that a company should choose for its peer group other companies that compete with it for talent, customers that compete with it for talent, customers and investor capital. But changes in the market caused by factor such as mergers and acquisitions can leave companies in a constant search for a relevant mix of peers.
Perhaps indication how difficult it is to choose peers. Time Warner appears to have Johnson & Johnson in its peer group (as it would fit in the group comprising companies with more than $10 billion in revenues), while Johnson & Johnson does not include Time Warner.
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